Case Study: Helping jittery clients with education plan

The expert

Jay Nash, investment advisor and portfolio manager, London, Ontario, Wellington West Capital Inc.

The client

The Chois, a married couple with three children aged 7, 9 and 11.

The problem

The parents opened an RESP in 2008 using globally balanced mutual funds, but when the market crashed, they lost 17%. Although comparatively minor given the 39% drop in the S&P 500 through the end of 2008, the loss made the Chois uncomfortable with equity markets. The Chois needed to know the money would be there when their eldest reached university age. Unwilling to wait for a rebound, they sold 40% of their mutual funds for cash, crystallizing the loss but changing the portfolio so they were comfortable with future return risks.

The solution

In 2008, the family’s RESP contained $50,000 in globally balanced mutual funds. The family’s goal is to use the RESP for university expenses starting in 2018 and wind up the vehicle by 2026. Following the 2008 correction, the family’s dollar-return objective was adjusted to 5% per year over the life of the fund. This shifted much of the portfolio to income positions.

During the downturn of 2008, the family sold $20, 000 in mutual funds, and in 2009 bought a Canadian DEX Real Return Bond ETF, which offered 2.48% trailing yield. The bond ETF’s management fee was 1% lower than comparable mutual funds— an advantage given the low-interest-rate environment. In addition, the Chois were more comfortable, with the set-it and forget-it structure the ETF offered, rather than an actively managed fund.

The month after the first ETF purchase, Nash bought the family’s a corporate bond ETF with a 4.63% yield. The family now had an RESP portfolio containing 40% mutual funds, 55% ETFs and 5% cash. They continued to deposit money into the RESP each month— into globally balanced mutual funds, as their confidence increased. The ETFs remained untouched as the mutual funds grew.

Advisors learn a client’s true risk tolerance during a crisis.

Despite the Chois’ long-term objectives, they lowered their risk level during the 2008 correction, and regular distributions form the ETFs provided emotional comfort. Yet the Chois would have made their money back and more had they held on to their equity position, so it can pay to talk your clients down.

Two years later, the first ETF had returned 17%. Nash suggested they sell it and buy an alternative fixed-income investment offering superior yield and less risk. Real-return bonds do well when interest rates fall, but with long-term rates at historical lows and dim inflation prospects, it was a good time to sell. The Chois sold near the ETF’s peak.

Their RESP portfolio weathered the August market troubles. Its positive annual return was 2.5% each year over the past three, well above benchmark. Current assets in the RESP total $81,000— 20% cash, 55% income and 25% equity, representing a conservative risk level. While the eldest child is seven years from entering university, the market uncertainties of the past decade illustrate how short a time that can be.